SEC’s Gallagher Calls for Floating Price for Money Funds

Sept. 27 (Bloomberg) -- U.S. Securities and Exchange
Commission member Daniel Gallagher, who helped derail efforts to
tighten rules for money-market mutual funds, said he would
likely support a measure forcing the industry to abandon its
marquee $1 share price.

Requiring money funds to have a fluctuating share price
“is an attractive option that I am likely to support,”
Gallagher, a Republican, said in an interview.

The remarks could help revive the debate at the SEC and
offer a path toward compromise for SEC Chairman Mary Schapiro,
whose proposal ran aground last month.

Gallagher said he couldn’t vote for Schapiro’s plan because
its centerpiece was to make the funds hold extra capital. The
cushion was too small to protect investors, Gallagher said,
leading him to believe the money would be used as collateral in
case the funds needed to borrow from the Federal Reserve.

“I could not be complicit in a rulemaking that purported
to eliminate bailouts but would actually do the opposite,”
Gallagher said.

SEC spokeswoman Judith Burns declined to comment.

The Financial Stability Oversight Council, an umbrella
group of U.S. regulators headed by Treasury Secretary Timothy F.
Geithner, may discuss money funds at a meeting tomorrow.
Schapiro, a member of the council, has asked the group to
consider taking action to stabilize money funds.

Lobbying Campaign

Much of the mutual-fund industry -- led by Boston-based
Fidelity Investments and Pittsburgh-based Federated Investors
Inc. -- has waged a lobbying campaign against any SEC action,
especially giving up the stable share price.

The SEC, along with the Fed and Treasury Department, has
pressed to make money funds safer since the September 2008
collapse of the $62.5 billion Reserve Primary Fund, which
triggered an industrywide run and helped freeze credit markets.
The crisis calmed only after the Treasury temporarily guaranteed
shareholders against losses and the Fed began buying fund assets
at face value to help them meet redemptions.

Schapiro has argued that the funds’ $1 share price
encourages investors to flee at the first sign of trouble.
That’s because those who act quickly can sell shares at $1 each
even if the net asset value has dropped below that level.

Legally Bound

The industry has maintained that a floating share price
would make money funds unworkable for many investors by saddling
them with new accounting and tax obligations. In addition,
insurers, municipalities and other large users of money funds
are often legally bound to invest assets they account for as
cash in funds with a stable share price.

“We continue to oppose a floating NAV,” Vincent
Loporchio, a spokesman for Fidelity, said in an interview. “At
the same time we remain committed to working with policy makers
to introduce regulations that will not have significant negative
consequences for investors and for the economy.” Fidelity is
the largest provider of U.S. money-market mutual funds.

The Investment Company Institute believes “a thorough SEC
analysis of forcing money market funds to float” their share
price would conclude that it “is an untenable option,” Ianthe
Zabel, a spokeswoman for the Washington-based mutual fund trade
association, said in e-mail.

Capital Cushion

Schapiro gave up on her plan on Aug. 22 after three of the
five commissioners -- Republicans Gallagher and Troy Paredes,
joined by Democrat Luis Aguilar -- told her they wouldn’t vote
to issue it for public comment. Her proposal spelled out two
options, the capital cushion coupled with some restrictions on
redemptions, or the floating share price.

In a statement that day she urged “other policy makers”
to take up the issue saying it was too important to “put our
head in the sand and wish it away.”

Gallagher previously expressed skepticism of the SEC’s
proposals while stopping short of rejecting a floating share
price. In a December speech, Gallagher said the commission
should first analyze the impact of money-market rules the SEC
put into place in 2010, saying that “any rulemaking in this
space could be premature, and possibly unnecessary.”

Gallagher also said a measure forcing funds to abandon the
stable $1 share price “is an important option to keep on the
table and to subject to further study and consideration.”

Further Study

On Aug. 28, Gallagher and Paredes said they supported an
alternative that would allow firms running money funds to
prohibit withdrawals to stop investor flight in the event of a
run. They backed Aguilar’s call for further study on whether new
rules could cause investors to move money from money-market
funds to other unregulated investments.

In the interview, Gallagher said his support of a floating
share price was contingent on the SEC “fully understanding and
addressing” the tax and accounting issues that could arise.
Gallagher said a fluctuating share price may need to be coupled
with other protections, such as the freezing redemptions option
that he and Paredes had suggested.

While Schapiro’s plan offered the variable share price as
one alternative, Gallagher said it was secondary to the capital
buffer. The proposal included about 150 pages describing the
capital buffer and just 40 pages on the floating share price.

‘Stalking Horse’

“It was intended to act as a stalking horse to push the
industry to support the capital buffer proposal,” he said.

While Schapiro’s plan didn’t say the capital could be used
for collateral for borrowing from the Fed, Gallagher said, “I
came to understand that this is likely what was intended.”

Robert Plaze, former deputy of the SEC’s division of
investment management who spearheaded the proposal, disputed
Gallagher’s contention.

“The staff recommendation to the commission presumed that
money-market funds would not have access to the Fed window,”
Plaze said in an interview.

Regulators rejected an earlier proposal to create a
liquidity facility for the industry in part because it could
have opened the door for Fed lending.

Setting up a Fed-run lending program for money funds during
an emergency would help the largest banks continue to fund their
own operations via the short-term credit markets while not
protecting the companies and individual investors who rely on
money funds as a safe place to park their cash, Gallagher said.

“This whole exercise has been about the role that money
market funds play in the short-term funding markets on which
banks rely, something that FSOC members are very concerned
about,” Gallagher said. “It was never really about
investors.”